Alfa Laval. Accumulate. Company report. Cooling off could still be hot

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1 Company report Alfa Laval Sweden/Industrial Engineering Investment Research Accumulate Share price: SEK closing price as of 11/05/2009 Target price: SEK Reuters/Bloomberg ALFA.ST/ALFA SS Daily avg. no. trad. sh. 12 mth 3,869,572 Daily avg. trad. vol. 12 mth (m) Price high 12 mth (SEK) Price low 12 mth (SEK) Abs. perf. 1 mth 7.4% Abs. perf. 3 mth 3.5% Abs. perf. 12 mth -29.8% Market capitalisation (SEKm) 30,809 Current N of shares (m) 422 Free float 82% Cooling off could still be hot We initiate coverage of Swedish engineer Alfa Laval with an Accumulate rating and a target price of SEK90. Despite poor recent orders, Alfa s earnings are likely to hold up better than the market expects, due to fixed-cost sharing and a high proportion of variable costs. The valuation is very supportive, boosted by good cash flow conversion and one of the sector s strongest balance sheets. On the negative side, even though book-to-bill should trough shortly, the earnings recovery is likely to come later than for many peers in the sector. 12 May 2009 Very strong fundamental properties: Alfa Laval, the world s largest manufacturer of heat exchangers and separators, has several virtues: high endmarket and cost structure diversification, strong pricing power and relatively high exposure to (currently unfashionable) growth areas, such as BRIC countries and energy efficiency. Add in a solid balance sheet, and we consider the shares as an attractive holding in the sector. We expect trough margins of 14-15%: In , we believe Alfa Laval s margins were boosted by price/mix of around six percentage points. It is likely to have to give back 4pp of this, but, given its good cost diversification and low operational gearing, we expect margins to trough as high as 14-15%. Key financials (SEK) 12/08 12/09e 12/10e Sales (m) 27,850 26,790 24,726 EBITDA (m) 6,296 4,787 4,189 EBITDA margin 22.6% 17.9% 16.9% EBIT (m) 5,736 4,129 3,440 EBIT margin 20.6% 15.4% 13.9% Net Profit (adj.)(m) 3,774 2,730 2,356 ROCE 29.9% 20.5% 17.4% Net debt/(cash) (m) 2, (1,073) Net Debt Equity Net Debt/EBITDA Int. cover(ebitda/fin.int) EV/Sales EV/EBITDA EV/EBITDA (adj.) EV/EBIT P/E (adj.) P/BV OpFCF yield 11.1% 7.3% 9.1% Dividend yield 3.1% 3.1% 3.4% EPS (adj.) BVPS We are already some way into the order weakness: Even though Alfa is latecycle and orders are unlikely to start growing until 2010, it is worth noting that book-to-bill peaked as early as Q1 07 and should trough in mid Marine not dead quite yet (should be soon): It is important to distinguish between marine orders and sales. The market may be overestimating the drop in 2009 and 2010, as sales were never inflated as much as orders were, and yard delays are smoothing and prolonging deliveries. That said, when deliveries are over, there is likely to be a very long drought. Attractively valued: Compared to peers, Alfa trades at a discount of 29-36%, on EV/EBIT E, which seems an excessive discount when normalising earnings across the cycle. Our DCF returns a fair value of SEK113. Allowing for a discount to DCF in line with the sector, we set our 12M target price at SEK90, corresponding to 11x 2010E trough earnings. Our greatest objection is a less exciting earnings profile than the sector. One should not hope for an earnings rebound until late next year, as Alfa still needs to work off its inflated order book. 110 vvdsvdvsdy Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Oct 08 Nov 08 Dec 08 Jan 09 Feb 09 Mar 09 Apr 09 May 09 Analyst(s): Anders Idborg Carl Holmquist Jan Bjerkeheim Carl Gustafsson ALFA LAVAL DJ Stoxx Industrial Engineering (Rebased) Source: Factset Shareholders: Tetra Laval 18%; AMF Pension 6%; Robur 6%; For company description please see summary table footnote Produced by Danske Markets Equities, a member of ESN Distributed by the members of ESN (see last page of this report) All ESN research is available on Bloomberg: ESNR <go>

2 Alfa Laval: Summary tables PROFIT & LOSS (SEKm) e 2010e 2011e Sales 19,802 24,849 27,850 26,790 24,726 25,717 Cost of Sales & Operating Costs (excl. Pers. Expenses) Personnel Expenses Non Recurrent Expenses/Income EBITDA 3,153 5,299 6,296 4,787 4,189 4,398 EBITDA (adj.)* 3,153 5,299 6,296 4,787 4,189 4,398 D & A EBIT 2,552 4,691 5,736 4,129 3,440 3,687 EBIT (adj.)* 2,552 4,691 5,736 4,129 3,440 3,687 Net Financial Interest Other Financials Associates Other Non Recurrent Items Earnings Before Tax (EBT) 2,375 4,556 5,341 3,926 3,366 3,764 Tax ,377-1,534-1, ,129 Tax rate 27.4% 30.2% 28.7% 29.5% 28.8% 30.0% Discontinued Operations Minorities Net Profit (reported) 1,687 3,136 3,774 2,730 2,356 2,595 Net Profit (adj.) 1,687 3,136 3,774 2,730 2,356 2,595 CASH FLOW (SEKm) e 2010e 2011e Cash Flow from Operations before change in NWC 2,696 3,852 3,257 3,425 3,146 3,345 Change in Net Working Capital Cash Flow from Operations 2,504 3,020 3,770 3,914 3,329 3,257 Capex , Net Financial Investments -1,223-1, Free Cash Flow 927 1,344 2,437 2,236 2,810 2,691 Dividends ,055 Other (incl. Capital Increase & share buy backs) 1,101-2,385-2, Change in Net Debt 1,458-1, ,287 1,860 1,636 NOPLAT 1,853 3,273 4,089 2,909 2,408 2,581 BALANCE SHEET & OTHER ITEMS (SEKm) e 2010e 2011e Net Tangible Assets 2,514 2,824 3,546 4,851 4,861 4,916 Net Intangible Assets (incl.goodw ill) 4,897 5,734 7,273 6,987 6,747 6,547 Net Financial Assets & Other 784 1,133 1,376 1,376 1,376 1,376 Total Fixed Assets 8,196 9,691 12,195 13,214 12,984 12,839 Net Working Capital 3,257 4,397 2,866 2,377 2,194 2,281 Shareholders Equity 6,713 7,846 10,378 12,159 13,566 15,105 Minorities Equity Net Debt 1,478 2,410 2, ,073-2,709 Provisions Other Net Liabilities or Assets 3,143 3,741 2,494 2,494 2,494 2,494 Net Capital Employed/Invested 11,452 14,088 15,061 15,591 15,178 15,121 GROWTH & MARGINS e 2010e 2011e Sales growth +chg 25.5% 12.1% -3.8% -7.7% 4.0% EBITDA growth +chg 68.0% 18.8% -24.0% -12.5% 5.0% EBITDA (adj.)* growth +chg 68.0% 18.8% -24.0% -12.5% 5.0% EBIT growth +chg 83.8% 22.3% -28.0% -16.7% 7.2% EBIT (adj)*growth +chg 83.8% 22.3% -28.0% -16.7% 7.2% Net Profit growth +chg 85.9% 20.3% -27.7% -13.7% 10.1% EPS adj. growth +chg 92.1% 23.3% -27.7% -13.7% 10.1% DPS adj. growth 22.5% 44.0% 0.0% 0.0% 11.1% 10.0% EBITDA margin 15.9% 21.3% 22.6% 17.9% 16.9% 17.1% EBITDA (adj)* margin 15.9% 21.3% 22.6% 17.9% 16.9% 17.1% EBIT margin 12.9% 18.9% 20.6% 15.4% 13.9% 14.3% EBIT (adj)* margin 12.9% 18.9% 20.6% 15.4% 13.9% 14.3% Page 2

3 Alfa Laval: Summary tables RATIOS e 2010e 2011e Net Debt/Equity Net Debt/EBITDA Interest cover (EBITDA/Fin.interest) nm Capex/D&A 58.9% 78.5% 108.4% 254.8% 69.3% 79.6% Capex/Sales 1.8% 1.9% 2.2% 6.3% 2.1% 2.2% NWC/Sales 16.4% 17.7% 10.3% 8.9% 8.9% 8.9% ROE (average) 27.2% 43.1% 41.4% 24.2% 18.3% 18.1% ROCE (adj.) 17.4% 25.3% 29.9% 20.5% 17.4% 18.8% WACC 7.1% 7.1% 7.1% 7.1% 7.1% 7.1% ROCE (adj.)/wacc PER SHARE DATA (SEK) e 2010e 2011e EPS (reported) EPS (adj.) BVPS DPS VALUATION e 2010e 2011e EV/Sales EV/EBITDA EV/EBITDA (adj.)* EV/EBIT EV/EBIT (adj.)* P/E (adj.) P/BV Total Yield Ratio 2.0% 6.2% 5.6% 3.1% 3.4% 3.8% EV/CE OpFCF yield 6.2% 6.5% 11.1% 7.3% 9.1% 8.7% OpFCF/EV 6.0% 6.1% 10.3% 7.0% 9.3% 9.4% Payout ratio 41.4% 31.0% 25.2% 34.8% 44.8% 44.7% Dividend yield (gross) 2.0% 2.5% 3.1% 3.1% 3.4% 3.8% EV AND MKT CAP (SEKm) e 2010e 2011e Price** (SEK) Outstanding number of shares for main stock Total Market Cap 34,507 39,337 28,488 30,809 30,809 30,809 Net Debt 1,478 2,410 2, ,073-2,709 o/w Cash & Marketable Securities 775 1,046 1,627 1,340 3,214 5,143 o/w Short Term Debt o/w Long Term Debt 2,034 3,117 3,454 1,985 1,999 2,272 Other EV components Enterprise Value (EV adj.) 35,985 41,747 30,562 31,953 30,140 28,539 Source: Company, Danske Markets Equities estimates. Notes * Where EBITDA (adj.) or EBIT (adj.)= EBITDA (or EBIT) +/- Non Recurrent Expenses/Income **Price (in local currency): Fiscal year end price for Historical Years and Current Price for current and forecasted years Company Description: Alfa Laval produces heat exchangers, high speed separators and products for sanitary fluid handling. The products are used in a w ide variety of fields, including energy, food and beverages and marine. Page 3

4 This report has been prepared by Danske Markets Equities, which is a part of Danske Bank. Danske Bank is under supervision by the Danish Financial Supervisory Authority. The author of this report is Anders Idborg, Equity Analyst. Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high quality research based on research objectivity and independence. These procedures are documented in the Danske Bank Research Policy. Employees within the Danske Bank Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and to the Compliance Officer. Danske Bank Research departments are organised independently from and do not report to other Danske Bank business areas. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. The Equity and Corporate Bonds analysts of Danske Bank are not permitted to invest in securities under coverage in their research sector. Danske Bank is a market maker and may as such hold positions in the financial instruments mentioned in this report. Danske Bank has made no agreement with Alfa Laval to write this report. Parts of this report have been disclosed to Alfa Laval. No recommendations or opinions were amended following this disclosure before dissemination. Danske Bank research reports are prepared in accordance with the Danish Society of Investment Professionals Ethical rules and the Recommendations of the Danish Securities Dealers Association. Financial models and/or methodology used in this report Recommendations and opinions in this research are formed based on a combination of Discounted Cash Flow analysis, industry knowledge, peer group analysis, and company specific and market technical elements (events affecting both the financial and operational profile of the company). Forecasting of company sales and earnings is based on segmented bottom up models using subjective views of relevant future market developments. The output is aggregated into models for group profit and loss, balance sheets and cash flow estimates all taking into account the recent development in historical reports. In addition, company guidance and financial guidance is taken into account. Risk warning Major risks connected with recommendations or opinions in this report, including a sensitivity analysis of relevant assumptions, are stated in the text. In addition, see the front page of this publication for a categorisation of the risk (above average, average, and below average) of investing in Alfa Laval compared to the coverage universe as a whole. Expected updates This research product will be updated on a quarterly basis following the quarterly result statements from the company. Please see the front page of this research report for the first date of publication. Recommendation structure The Danske Markets Equities Recommendation System is Absolute. It means that each stock is rated on the basis of a total return, measured by the upside potential (including dividends and capital reimbursement) over a 12 month time horizon. The Danske Markets Equities spectrum of recommendations (or ratings) for each stock comprises 5 categories: Buy, Accumulate (or Add), Hold, Reduce, Sell, (in short: B, A, H, R, S). In specific cases and for a limited period of time, the analysts do have to rate the stocks as Rating Suspended (RS) or Not Rated (NR), as explained below. Meaning of each rating or recommendation: Buy: the stock is expected to generate a total return of over 20%+ during the next 12 months time horizon. Accumulate: the stock is expected to generate a total return of 10% to 20% during the next 12 months time horizon. Hold: the stock is expected to generate a total return of 0% to 10% during the next 12 months time horizon Reduce: the stock is expected to generate a total return of 0 to -10% during the next 12 months time horizon Sell: the stock is expected to generate a total return below -10% during the next 12 months time horizon Rating Suspended: the rating is suspended due to a capital operation (take-over bid, SPO, ) where the issuer or a related party of the issuer is or could be involved or to a change of analyst covering the stock Not Rated: there is no rating for a company being floated (IPO) by the issuer or a related party of the issuer Page 4

5 Within the past quarter Danske Markets Equities has had investment recommendations on 173 securities. The distribution of recommendations is represented in the Securities ratings breakdown diagram below. Securities ratings breakdown Reduce 14% Sell 7% Buy 30% Hold 26% Accumulate 23% The proportion of issuers corresponding to each of the recommendation categories above to which Danske Bank has provided investment banking services within the previous 12 months is shown below. Rating Investment banking relationships Buy 14% Accumulate 5% Hold 13% Reduce 4% Sell 25% Changes in recommendations in the last 12 months: Date Recommendation New recommendation Danske Markets Equities initiated coverage of the stock on 12 May 2009 with an Accumulate rating Disclaimer: This publication has been prepared by Danske Markets for information purposes only. It has been prepared independently, solely from publicly available information and does not take into account the views of Danske Bank s internal credit department. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. The Equity and Corporate Bonds analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for retail customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S. Danske Bank A/S is authorized by the Danish Financial Supervisory Authority and subject to limited regulation by the Financial Services Authority (UK). Details on the extent of our regulation by the Financial Services Authority are available from us on request. Copyright Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission. Page 5

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